How to Maintain 501c3 Tax-Exempt Status (Step-by-Step) (2024)

Obtaining tax-exempt status as a 501c3 organization is highly valued. Any nonprofit group dedicated to one or more of the approved purposes can be granted immunity from income tax with an approved 1023 application. However, to maintain 501c3 status, it must uphold the strict 501c3 requirements, including fulfilling its role in the community, avoiding for-profit and privately beneficial behaviors, and carefully not participating in politics.

Maintaining 501c3 status is a yearly effort usually taken on by a nonprofit’s board of directors. Learn what steps the board must take to maintain tax-exempt status.

501c3 nonprofits are organizations that are exempt from federal income tax under section 501c3 of the Internal Revenue Code. It’s important to note that 501c3 requirements vary greatly from state to state (requirements in Pennsylvania are vastly different than those in Georgiaor Colorado). However, the federal government maintains a few core requirements that all organizations must meet.

501c3 organizations typically provide one or more valuable services for the local community. According to the IRS, approved exempt purposes include “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”

To maintain tax-exempt status, organizations must adhere to 501c3 requirements from both state and federal law. The process generally involves the following steps.

1. File Annual Information Returns (Form 990)

First, you must file an annual return every year. The type of Form 990 depends on the nonprofit’s financial activity:

• 990-N: Gross receipts less than $50,000
• 990 or 990-EZ: Gross receipts less than $200,000, and total assets greater than $500,000
• 990: Gross receipts greater than $200,000, or total assets greater than $500,000
• 990-PN: Private foundations regardless of financial activity.

2. Operate Within Exempt Purposes

The operations of a 501c3 organization are highly regulated. There is a list of requirements and a similarly important list of prohibitions. You will need to maintain operations that adhere strictly to both lists.

Requirements:

• Faithfully pursue your stated purpose when you were granted the 501c3
• Continue serving the community
• Pay your employees a market wage
• Clearly report all earnings and allocations of funds

Prohibitions:

• Generate too much profits from private enterprise
• Allow earnings to benefit private individuals or shareholders
• Participate in electoral campaigns or lobbying

3. Avoid Excess Benefit Transactions

One of the key elements of maintaining a 501c3 tax-exempt status is not operating as a for-profit organization. 501c3s are permitted to conduct some transactions, like selling products to fundraise. However, excess benefit transactions can harm your status. The exact percentage of income that can come from transactions is not specified, but precedent sets the amount considered excess at between 25% and 30%.

4. Maintain Proper Records and Documentation

Maintaining proper records and documentation is crucial for 501c3 organizations to demonstrate compliance with IRS regulations and retain their tax-exempt status. Securely store the following documents and records:

• Financial records
• Donation records
• Board meeting minutes
• Compliance documents
• Employee records

5. Comply With State Regulations

Lastly, while 501c3 relates to federal income tax, the laws regarding qualification and maintenance of this status vary by state. Know the regulations associated with the state or states in which your organization operates and ensure that you are consistently in compliance.

Maintaining 501c3 tax-exempt status requires strong corporate governance, a concerted effort from your nonprofit board, and a nonprofit leader to oversee it all.

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RELATED READING:

• 501c3 vs. 501c4: What’s the Difference?
• How to Start a Nonprofit in Michigan (Step-by-Step)
• Board Evaluation Process in 5 Easy Steps

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